How Lenders Determine How Much to Lend

by Ruth Hall . 2 Comments

How do Lenders Determine How Much House You Can Afford?

Before you begin searching for a home, it is imperative to be realistic about your circumstances. You must know how much of a house you can afford, if you can afford one at all. Sometimes, after reviewing your current situation, you may need to stay a renter for a little longer until you can purchase a home without going bankrupt. Here are the top factors lenders typically consider when determining how much house you can afford.

One of the first factors a lender will analyze is your debt-to-income ratio. Lenders use this measurement to ensure that you’ll have enough income to cover both your new mortgage payment as well as any outstanding loans you already have. Examples of other debt may include student loans, credit card debt, or auto loans. Lenders will expect your new monthly mortgage payment to not exceed 36% of your other outstanding debts. You can calculate this ratio yourself by taking your total monthly debt load and dividing it by your monthly gross income.

Your credit is the most important thing when looking to purchase a home. It will determine whether you are able to buy a home at all, how much of a loan you are able to get, as well as the interest rate. Credit scores are based on your previous payment history, overall level of debt, length of credit history, types of credit and applications for new credit.

Lenders will be apprehensive to lending to you if your credit, or age of credit is less than ideal. If this is the case, you may still be able to obtain a loan, but you will more than likely be paying a higher mortgage and interest rate, and also be required to submit a higher down payment.

There are great deals out there for first time home buyers. That being said, there is almost no way to get out of having straight cash for a down payment. A down payment is typically 20% of the home. You will always get a better interest rate for a loan on a home (and really any other loan for that matter) if you are able to pay a down payment of at least that percentage. Furthermore, that amount does not include closing costs, which usually amount to about 2-5% of the total sale price of the home.

If your credit is poor or lacking, consider waiting to purchase a home until you improve your credit score, and/or are able to increase your income. Ideally, you should be debt-free when purchasing a home, and also have 3-6 months of your expenses saved before making the leap. Of course, this is in addition to having money for a down payment and the costs of closing on the house.

For an interesting video, watch How do Banks Determine Mortgage Interest Rates? and the following article about Will Having a Mortgage Improve My Credit Score?

2 Responses to How Lenders Determine How Much to Lend

  1. Eric says:

    I would wait to apply for a mortgage until you have a substantial length of credit history. That doesn’t mean you need to wait ten years, but it’s helpful if you you have a few credit cards, a car payment, and have good income. The credit cards an auto loan show that other lenders are willing to lend to you. If you’ve got enough cash to put down a very large downpayment then the small length of credit history might not apply to you very much.

    February 29, 2016 at 9:34 pm
  2. Joann says:

    Definitely don’t apply for a mortgage without credit. You aren’t going to get the loan. All you’ll get is a nice 5 point reduction in your credit score due to the credit inquiry.

    March 26, 2017 at 3:53 pm

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